In the last couple of weeks, we’ve all heard about the shutdown in parts of the US public sector following the failure of Congress to pass a budget. A number of people have asked me, “So, what does all this stuff in America mean for us.” Here, I try to highlight the main themes and risks.
Each year, the executive (President Obama’s government) sets out its budget plans and the legislature (Congress) debates and amends it and then votes it through for the Presidency to sign into law. But, the Senate and/or the House of Representatives, particularly if they have a majority vote for the ‘other’ party (as the House does currently), often table their own budget proposals. Over the spring/early summer, the different options are argued about, within and between the two parts of Congress, and negotiated with the Executive. Usually, a single united budget for the next year is set, voted through and signed off before they all go away for the summer… well ahead of the end September deadline. This year, following the split 2012 elections and the desire of the “tea-party” wing of the Republicans to reverse or delay “Obamacare”, the sides failed to agree by the deadline, causing the shutdown. Without a renewed mandate from Capitol Hill, the Executive had no authority to spend on about one third of its current activity after 1st October.
More importantly, America is also approaching its debt ceiling. Congress sets an absolute US$ amount of debt (government bonds) that the Executive/Treasury can issue to finance US government spending. Every few years, through the process of growth, inflation and political largesse, Federal America comes up against this ceiling and a higher one has to be approved. Often, this is a formality but, with the Republican majority in the House wanting to force the Democratic Presidency into more debate about cuts to government spending, not this year. The next deadline is on or around17th October because that is when the government starts to run out of cash and may not be able to roll over its debts falling due.
Whatever the rights or wrongs of the politics, there are potentially significant economic ramifications for us all if these two matters are not resolved speedily.
- The immediate effects of the shutdown are relatively minor. It could shave a few percentage points off US GDP growth directly through the cut in government spending and indirectly through supply chains effects and lower consumption by the federal employees who are not being paid. But, assuming the furlough is brief (the last and longest was for 3 weeks nearly two decades ago under President Clinton), the effects of the shutdown should be made up before Christmas. If it were to persist for longer than expected, it would lower US growth this year. Trade and financial flows would be reduced and the dollar might slip, affecting our exporters and investors. But, again, the lost ground should then be made up in 2014. Although some US individuals and activities can be badly affected in the near term, shutdowns cause little or no damage to the overall macro economy. Indeed, by focusing public attention on the scale of government, they can have a positive side effect – restricting the rise in federal spending relative to GDP growth over the medium term.
- Although, again, it depends on how long it lasts, the effects of the debt ceiling barrier are potentially more serious. Not being able to borrow would affect US spending much more significantly. It could hit confidence hard, hurting investment and hiring decisions, stock market valuations and the currency. Moreover, if there was an actual default – a failure to roll over existing US treasury bill or bond debts – the damage to global markets could be severe. The risk or reality of a default by the world’s biggest debtor – allegedly a ‘safe haven’ – could start a shock wave of distrust that would overwhelm anything we have seen with Spain, Greece, Italy, Cyprus, Portugal or Ireland. Frightened of losing funds that they thought were safe in America, investors would sell off other non-US assets to recoup liquidity. In the rush for the exits, many banks would face a fresh and possibly large credit crunch. Moreover, with monetary policy makers already setting interest rates as low as possible and many treasuries fiscally strapped, the room for counter-action is severely constrained. Few economies would be safe from such a tsunami.
If the worst happens, the Treasury would run out of cash in about a month, forcing spending cuts worth an estimated 4% of GDP and starting another US recession. For a while at least, the Federal Reserve can print even more dollars to pay off US$ loans. But, that would devalue the monetary base and the currency, leading to higher inflation and other economic problems down the line. There is little doubt who would get the blame – are US politicians suicidal?. Surely, an actual default will be avoided.
What is happening between the two ends of Pennsylvania Avenue in Washington may seem a long way from your economic life but, if they mess it up, 2008’s credit collapse will be written about as merely the first stage of a deeper and longer malaise in the world economy. 2013 could become the new 1929 and our economy, businesses and jobs, could not remain aloof from such a catastrophe.
Surely, they are not that stupid. I expect this will all be settled in a few weeks and this blog will pass into myth and legend – at least, until the next time we approach a political impasse. There could even be an upside to this crisis. If it forces a real, non-partisan debate about the state of the US public finances and their relationship with the private economy, it could result in a better outcome for us all. To paraphrase Winston Churchill (and Stephen Stills), “remember the Americans will try all the wrong things before doing the right thing”.